Analysis of Rappaport Value Drivers: A Comparative Study of AZN and GSK

The assignment discusses the financial performance of AstraZeneca (AZN) and Glaxosmithkline (GSK), two companies in the Biotechnology and Pharmaceutical industry, using Rappaport value drivers. The analysis reveals that AZN has higher shareholder returns than GSK, with positive values in every year compared to GSK's fluctuating trend. Additionally, it highlights the importance of factors such as revenue, operating margin, cash tax rate, incremental capital expenditure, investment in working capital, cost of capital, and competitive advantage period in determining a company's ability to provide dividends to shareholders.

CORPORATE
FINANCIAL STRATEGY

INTRODUCTION
The area and aspect in which a company or an organisation deal with the different
financing sources as well as capital structure which are related to the financial department is
known as corporate finance. Apart from this in the corporate finance there are stock market
comes into consideration because it is the key part of every organisation which listed in
respective market. There are various number of strategies which are used in the corporate finance
for make it better and enhance level of profit. Further, the present case study is based on the
Glaxosmithkline (GSK) company which is operating in the Pharmaceutical, Consumer goods and
Biotechnology industry. Apart from this it is a public limited company and having global
presence. The current study shows about the discount rates, dividend policy as well as capital
structure of the GSK in context to the stock market. Beside this, the study describes about the
valuation of stock and dividend using different dividend ratios and models. Moreover, the study
helps to reader to analyse corporate life cycle of chosen firm using four aspects. At the end of
report, it describes about the shareholder value performance of the GSK and compare with the
AstraZeneca (AZN) company which operates in the same industry.
A) Discount Rates & Capital Structure
1. Calculation of Cost of Equity, Cost of Debt and Weighted Average Cost of Capital (WACC)
of Glaxosmithkline (GSK)
In the financing world there are different kinds of elements and available which helps to
management in order to assess its performance. When a business entity going to expand the firm
and enter in new market then it requires fund and capital which is provided by the several
sources of finance. Further, such all the financing sources imposes cost and charges in different
forms on the firm which uses its financing services. There are mainly two costs are analysed
using different formulas which are such as cost of equity and cost of debt. Moreover, cost of
equity associated with the equity financing while cost of debt associated with the debentures
which are denoted by Ke and Kd respectively (Jorda, Schularick and Taylor, 2016). On the basis
of such both the costs Weighted average cost of capital (WACC) is to determined of the firm.
Furthermore, Ke, Kd ad well as WACC of the GSK firm calculated and interpreted as below:
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Cost of Equity (Ke)
It is an aspect and cost related with equity financing which allow to the companies for
provide financial resources. Apart from this, it shows that the shareholder's required and
expected rate of return is up to which level behind investing money in GSK. On the basis of such
factor the management of firm analyse that how much expected return will be there with the
stockholders. It is explained along with calculation with reference to GSK as below:
For the year 2012
CAPM Assumptions 2012
K(e) 0.64%
RFR 1.0%
Beta 0.55
Rp 0.35%
For the year 2013
CAPM Assumptions
K(e) 1.09%
RFR 1.0%
Beta 0.46
Rp 1.19%
For the year 2014
CAPM Assumptions
K(e) -0.82%
RFR 1.0%
Beta 1.52
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Rp -0.20%
For the year 2015
CAPM Assumptions
K(e) -0.71%
RFR 1.0%
Beta 1.27
Rp -0.35%
For the year 2016
CAPM Assumptions
K(e) 1.12%
RFR 1.0%
Beta 0.75
Rp 1.16%
Analysis of Ke
From the above tables of the cost of equity analysis it can be analysed that Ke of GSK
was 0.64% in the year 2012 which increase in the further year up to 1.09%. Afterwards it starts
to reduce and reaches up to -0.71% in an accounting period 2015 which is good for the GSK. In
the financial year 2016 it again increases from -0.71% to 1.12% which shows that the company
issues more amount of shares and provide dividend on it. It can be clearly said that required rate
of return of the GSK is fluctuating every accounting year and if it reduces then profitable for it.
Cost of Debt (Kd)
Apart from cost of equity there is cost of debt is also associated with the firm behind
taking and raising capital from debentures. When the firm has more amount of debt then
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company has to pay higher cost which is not fare for it (Li, 2015). Furthermore, range of cost of
debt of the GSK over the five years is shown such as follows:
Particulars 2012 2013 2014 2015 2016
Long term debt 14671 15456 15841 15324 14661
Tax rate 20.00% 20.00% 20.00% 20.00% 20.00%
Cost of Debt (Kd) = Debt*(1-
tax rate) 11736.8 12364.8 12672.8 12259.2 11728.8
Analysis of Kd
The aforementioned table of cost of debt (Kd) shows that GSK raising capital and fund
from the debentures on increasing trend from FY 2012 up to 2014. Because of this cause cost of
debt increase from 11736.8 GBP to 12672.8 GBP from the FY 2012 to the 2014. Apart from this
at the end of accounting year 2015 and 2016 cost of debt reduces which are such as 12259.2
GBP and 11728.8 GBP respectively (GlaxoSmithKline PLC ADR, 2016). On the basis of the
analysis it can be said that GSK not taking financial resources by issuing debentures in the
market which lead to reduce the cost of equity in last two years.
Weighted Average Cost of Capital (WACC)
Along with the cost of debt and equity another model used by the company is Weighted
Average Cost of Capital which helps to analyse and determine total cost of the capital. It is the
combination of two types of costs which are associated with the equity and debentures (Cole and
Sokolyk, 2016). On the basis of this the GSK able to know and analyse total costs and expenses
which are firm needs to pay against raising fund. Calculation and interpretation of WACC with
reference to GSK is given as below:
For the year 2012
Enterprise Value (EV)
Current Market Price 43.47
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Diluted Shares 2,495
Market Capitalisation 108,458
Long Term Liabilities 14,671
Less: Cash & Cash Equivalents 3,906
Enterprise Value (in lacks) 119,223
Debt Equity Weightage
E/(D+E) @ Enterprise Value 88.08%
D/(D+E) @ Enterprise Value 11.92%
Interest Rate (%) 8%
Tax Rate (@) 20%
WACC Calculation 1.31%
For the year 2013
Enterprise Value (EV)
Current Market Price 53.39
Diluted Shares 2,460
Market Capitalisation 131,339
Long Term Liabilities 15,456
Less: Cash & Cash
Equivalents 5,231
Enterprise Value (in lacks) 141,564
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Debt Equity Weightage
E/(D+E) @ Enterprise Value 89.47%
D/(D+E) @ Enterprise Value 10.53%
Interest Rate (%) 8%
Tax Rate (@) 20%
WACC Calculation 1.62%
For the year 2014
Enterpsire Value (EV)
Current Market Price 42.74
Diluted Shares 2,433
Market Capitalisation 103,986
Long Term Liabilities 15,841
Less: Cash & Cash
Equivalents 4,028
Enterprise Value (in lacks) 115,799
Debt Equity Weightage
E/(D+E) @ Enterprise Value 86.78%
D/(D+E) @ Enterprise Value 13.22%
Interest Rate (%) 8%
Tax Rate (@) 20%
WACC Calculation 0.13%
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For the year 2015
Enterpsire Value (EV)
Current Market Price 40.35
Diluted Shares 2,444
Market Capitalisation 98,615
Long Term Liabilities 15,324
Less: Cash & Cash
Equivalents 5,486
Enterprise Value (in lacks) 108,453
Debt Equity Weightage
E/(D+E) @ Enterprise Value 86.55%
D/(D+E) @ Enterprise Value 13.45%
Interest Rate (%) 8%
Tax Rate (@) 20%
WACC Calculation 0.28%
For the year 2016
Enterpsire Value (EV)
Current Market Price 38.51
Diluted Shares 2,455
Market Capitalisation 94,542
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Long Term Liabilities 14,661
Less: Cash & Cash
Equivalents 4,605
Enterprise Value (in lacks) 104,598
Debt Equity Weightage
E/(D+E) @ Enterprise Value 86.57%
D/(D+E) @ Enterprise Value 13.43%
Interest Rate (%) 8%
Tax Rate (@) 20%
WACC Calculation 1.77%
Analysis of WACC
Year WACC
2012 1.31%
2013 1.62%
2014 0.13%
2015 0.28%
2016 1.77%
According to the above table it can be interpreted that GSK had WACC 1.31% for the FY
2012 which is increase in the further year and goes up to 1.62%. By this it can be said that in this
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period the management giving more cost of capital which lead to negative impact on the
profitability. Apart from this, from 2013 to 2014 it reduces which is such as 0.13% by which it
can be said that GSK having lesser amount of debt and equity. After the period of 2014 the
WACC enhances up to the FY 2016 and value of it in such year is 1.77%. Hence, it can be
analysed that GSK has more amount of equity capital as well as debt which lead to increase the
WACC. Higher and increasing trend of the WACC is unfavourable for the firm because it affects
to the profit level in negative manner.
2. Critically discussion of capital structure of Glaxosmithkline entity
When the firm going to raise capital from the external market and sources of finance then
using capital structure which comprises with the two aspects like as debt and equity. Standard
proportion of the capital structure or debt to equity is such as 0.5:1 that means when it raises
fund then debt needs to half of the total equity (Macve, 2015). Furthermore, capital structure of
GSK is such as follows:
2012 2013 2014 2015 2016
Debt to Equity
ratio
2.53 2.21 3.72 3.00 13.04
It can be analyse that capital structure of the GSK is such as 2.53 in the accounting year
2012 which continuously fluctuating over the five financial years. The capital structure is to
expressed using debt to equity ratio and when there is the current ratio is higher, then shows that
company not having appropriate strategies for raise the fund. It can be clearly analysed from
2012 to 2015 the capital structure of GSK is higher but in this period all the values are nearby.
Apart from this in the year 2016 the management of GSK having higher proportion of debt
compare to the equity which is not good for it.
B) Dividend Policy
1. Calculation of dividend changes over the period of five years
Particulars 2012 2013 2014 2015 2016
Dividends 0.689 0.75 0.695 1.252 0.576
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Change in
% - 8.85% -7.33% 80.14% -53.99%
2012 2013 2014 2015 2016
-80.00%
-60.00%
-40.00%
-20.00%
0.00%
20.00%
40.00%
60.00%
80.00%
100.00%
8.85% -7.33%
80.14%
-53.99%
Analysis of Dividend policy of GSK
The above mentioned and formulated graph shows that GSK provides and allows
dividend amount to the shareholders in very fluctuating pattern. From the fiscal year 2013 to
2014 the dividend changes reduces which is from 8.85% to -7.33%. Apart from this, it increases
as well as decreases with the higher amount in 2015 and 2016 at where percentage change is
such as 80.14% and -53.99%.
2. Critically assessment of the dividend pay out by GSK
It can be clearly said using and analysing the above graph that company does not provide
with effective and proper dividend strategy which lead to make changes in each and every year.
It has not proper, appropriate as well as stable dividend policy and strategies by which the
respective figures are fluctuating. By analysing facts and figures of net income of GSK it can be
said that the firm providing dividend on the basis of its financial performance. When net profit of
the GSK is higher and lower, then it gives dividend according to the same direction (Cassar,
Ittner and Cavalluzzo, 2015). In year 2014 it reduces the dividend amount up to 7.33% because
net income also decreases from 5436 to 2756 GBP. Apart from this in the year 2015 change in
dividend amount is such as +80.14% and the reason behind is that NP enhances from 2756 GBP
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to 8372. Moreover, in the year 2016 the GSK earning net profit worth of 912 which reduce with
high rate from FY 2015 by which the management having -53.99% change in the dividend policy
or amount. Hence, it can be clearly said by comparing figures and level of net profit as well as
dividend amount that GSK gives dividend according to the financial condition.
3. Analysis of dividend consistent
It can be analysed in terms of dividend consistent that the GSK business entity provides
dividend amount to the shareholders by considering value of the net income generated. As the
net profit of the GSK increases from one FY to other year then company gives dividend with the
increasing trend. On the other side as level of the net income goes down then GSK declines
ration and amount of the dividend for the shareholders.
C) Valuation
Static Valuation Multiple
The valuation is related to the financial process which helps to the business entity in
order to determine worth of the firm in the stock market. When there are valuation level of the
company is higher, then it shows that management able to generate more amount of profit and
gives high return on investment amount of shareholders (Johnstone, 2015). There are mainly two
types of ratios are used for static valuation of the GSK which are calculated as below:
Price Earnings Ratio
Particulars 2012 2013 2014 2015 2016
Share price 46.23 51.64 55.37 46.15 42.91
Earnings per share 1.8 2.21 1.13 3.45 0.37
Price Earnings
Ratio 25.68 23.37 49.00 13.38 115.97
Dividend Yield Ratio
Particulars 2012 2013 2014 2015 2016
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Dividends 0.689 0.75 0.695 1.252 0.576
Share price 46.23 51.64 55.37 46.15 42.91
Dividend
yield ratio 1.49% 1.45% 1.26% 2.71% 1.34%
Analysis
From the above tables of static valuation it can be said that GSK having price earning
ratio with fluctuating trend from the FY 2012 to 2016. Along with this, there is dividend yield
ratio is also fluctuating over the periods of five years. From the financial period of 2012 to 2014
the PE ratio increases from 25.68 to 49 which shows that GSK having better performance in the
stock market and earns more higher amount behind every shares. Afterwards, in the FY 2015 PE
ratio reduces which is such as 13.38 and the improves in the year 2016. In the last accounting
year the company having the highest PE ratio which clearly indicates that it has better
performance. Along with this, as per the dividend yield ratio management of GSK gives dividend
with the fluctuating trend by which shareholders profit and return on the equity investment
changing in every financial year. In the year of 2015 GSK provide the highest dividend amount
to the shareholders and lowest in the accounting year 2016 which are such as 2.71% and 1.34%
respectively.
Absolute Valuation Technique
There are different types of methods and techniques which help to the company in order
to determine facts and figures about the growth of dividend amount paid by it to the
shareholders. In context to this, in the current case Dividend growth model is used by GSK
which is shown as below:
Dividend Growth Model
Particulars 2012 2013 2014 2015 2016
Dividend per
share (D) 0.689 0.75 0.695 1.252 0.576
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Required rate of
return (Ke) 0.64% 1.09% -0.82% -0.71% 1.12%
Growth (g) 0.069 0.069 0.069 0.069 0.069
Intrinsic value
(D/(Ke-g)) -11.01 -12.91 -9.00 -16.45 -9.97
Analysis
As per the current analysis and calculation of dividend growth model it can be said that
company not able to grow in context to the dividend aspect. On the basis of it intrinsic value of
GSK for the FY 2012 is such as -11.01 which declines and reaches up to -12.91 in the next year
2013. In context to this dividend's intrinsic value is such as -9.00 and -16.45 GBP in the
accounting year 2014 and 2015 respectively. It shows that company not having effectual and
positive performance in the stock market in terms of providing amount of dividend to the
shareholders. At the end of the FY 2016 GSK having intrinsic value of dividend is worth of -9.97
GBP under which it has lower dividend yield as compare to previous one.
D) Corporate Life Cycle
In the industry or corporate world, when the business entity exists in the market then
having different phases up to the last. When the firm enter and establish its business in the
industry then has introduction phase at where it contacting and interacting with the customers as
well as rivalry firms. Further, there are mainly four stages or phases of the corporate life cycle
from start to end which are such as introduction, growth, maturity and declines (Lagoarde-Segot,
2015). On the basis of corporate life cycle and strategy analysis of the GSK firm is given as
below:
Revenue & Profit Growth
According to the revenue aspect the company such as GSK has very low amount in the
accounting year 2014 among all the analysed periods which is worth of 23006 GBP. In context
to thus, revenue of the company increases in the further two years and at the end of 2016 it is
worth of 27889 GBP. When talking about the growth then management of the firm able to
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generate the highest return in the FY 2016 which indicates that firm is in the growth position.
According to the revenue figured of GSK it can be said that it is at the growth phase from 2014
to 2016.
Financing
The management of GSK using mainly two external financing sources for enhancing and
raising fund of any business purposes. In context to this, GSK has more proportion of the
debentures loan as compare to the equity capital. At the end of the accounting year 2016 the
GSK having higher debt compare to the equity and debt to equity ratio in respective period is
such as 13.04:1. On the basis of this the company GSK is at the growth stage because by using
more debt it able to expand and growth the firm in Pharmaceutical and Biotechnology industry.
Free Cash Flow
While talking about the free cash flow the business entity GSK is at the growth phase of
corporate life cycle because the respective value grows from the accounting year 2012 to 2016
from 2855 to 4145 GBP respectively. Between these all the years the there is free cash flow
reduces also on the overall basis GSK is in the growth stage.
Dividend Payout Ratio
The company has dividend strategy as well as dividend policy on the basis of profitability
ratios. As above analysed it can be that when at the workplace there is more net profit generated
by GSK then it provides higher dividend to the shareholders and vice-versa (Abroud and et.al.,
2015). On the basis of the respective factor and ratio like as dividend payout the firm GSK is at
the growth stage.
E) Shareholder's Value Performance
The value which is generated and earned by the shareholders from the company is
determined on the basis of mainly three aspects such as closing price of shares, opening price of
stock as well as amount of dividend paid by the firm. When there is higher dividend amount then
shareholder's value performance will also higher. In the current case scenario there are
shareholder's value performance is compared with the AstraZeneca (AZN) company which also
operating in the same industry. Furthermore, with the help of calculation shareholder's value
performance of both firms is analysed as below:
Glaxosmithkline (GSK)
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Particulars 2012 2013 2014 2015 2016
Close price 43.47 53.39 42.74 40.35 37.79
Open price 43 53.01 46.94 40.71 37.58
Dividends 0.689 0.75 0.695 1.252 0.576
Shareholder's
return 2.70% 2.13% -7.47% 2.19% 2.09%
AstraZeneca (AZN)
Particulars 2012 2013 2014 2015 2016
End price 47.27 59.37 70.38 33.95 27.32
Open price 23.94 28.68 37.18 34.33 26.21
Dividends 0.95 0.95 0.95 0.95 0.95
Shareholder's
return 101.42% 110.32% 91.85% 1.66% 7.86%
By considering the above table it can be said that the AZN company has shareholder's
value performance is higher and more as compare to GSK in the Biotechnology and
Pharmaceutical industry. The reason is that in every year AZN having positive values with the
higher figure than GSK. Apart from this on the basis of seven Rappaport value drivers
performance of both firms assessed as below:
Critically assessment of Rappaport Value Drivers
11 Revenue- By considering the revenue it can be said that GSK performing poor because it
gives very low amount of dividend to the shareholders compare to AZN.
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11 Operating margin- Dividend amount is paid by the GSK in the every financial years is
lower on the basis of making comparison with the AZN entity. Furthermore, the dividend
is paid to the shareholders after taken into consideration to the amount of profits. Hence,
it can be said that AZN has more profit and performing well in the Biotechnology and
Pharmaceutical industry.11 Cash tax rate- Higher the taxation rate and amount lead to reduce capability of the firm
for paying he dividend amount (Jorda, Schularick and Taylor, 2016). Moreover, it can be
stated that GSK having higher taxation which lead to reduce capability of it for giving
dividend.11 Incremental capital expenditure- On the basis of respective value drivers it can be said
that higher the capital expenses are lead to reduce the overall capability of the firm in
order to provide dividend.11 Investment in working capital- Higher the investment provide more return to the
company and on the basis of this GSK and AZN can give positive dividend to the
shareholders.11 Cost of capital- Apart from such value drivers other is cost of capital and when there is
higher value of cost capital company having then unable to give dividend to stockholders.11 Competitive advantage period- In the industry when an organisation has more and higher
competitive advantages, then able to create the effectual as well as higher value among
the stockholders.
CONCLUSION
From the above report of corporate financial strategy it can be summarised that
Glaxosmithkline (GSK) company having fluctuating trend of the cost of equity, cost of debt as
well as WACC. By considering the capital structure of GSK it can be said that it funds and raises
more amount capital using the debentures compare to equity financing. According to the
dividend policy, it can be concluded that the GSK providing dividend to the shareholders on the
basis of net income generated by it. At the last, it can be articulated that the GSK performing
poor as compare to AZN in terms of shareholder's value performance.
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